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Principles of Finance PDF

643 Pages·2022·59.59 MB·english
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The Principles of PPUUBBLLIICC FFIINNAANNCCEE A TEXT-BOOK FOR EVERY STUDENTS BBrroouugghhtt ttoo yyoouu bbyy AABBHHIIJJIITT KKUUMMAARR MMIISSRRAA COPYRIGHT NOTICE ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without the prior permission of the publisher. This book is sold subject to the condition that it shall not, by way of trade, be lent, re- sold, hired out or otherwise disposed of without the publisher’s consent, in any form of binding or cover other than in which it is published. Published at the publication house of OpenStax - a unit of Rice University. This book is specially designed for knowledge sharing and educational purpose. For any other information or query, please write to me at the following email: [email protected] ACKNOWLEDGMENT This book - “The Principles of Public Finance” is not a work of a single person. Many scholars have contributed and reviewed this book. Sincere thanks to our Senior Contributors Julie Dahlquist from Taxas Christian University & Rainford Knight from Florida Atlantic University. This book wouldn’t have been possible without them. Apart from them, there are other people who have also contributed to bring this book in the present form. Those are mentioned in the succeeding pages. Brought to you by ABHIJIT KUMAR MISRA CONTENTS Preface 1 1 Introduction to Finance 7 Why It Matters 7 1.1What Is Finance? 8 1.2The Role of Finance in an Organization 14 1.3Importance of Data and Technology 16 1.4Careers in Finance 18 1.5Markets and Participants 21 1.6Microeconomic and Macroeconomic Matters 23 1.7Financial Instruments 25 1.8Concepts of Time and Value 28 Summary 31 Key Terms 32 Multiple Choice 33 Review Questions 36 Video Activity 36 2 Corporate Structure and Governance 39 Why It Matters 39 2.1Business Structures 40 2.2Relationship between Shareholders and Company Management 44 2.3Role of the Board of Directors 46 2.4Agency Issues: Shareholders and Corporate Boards 50 2.5Interacting with Investors, Intermediaries, and Other Market Participants 54 2.6Companies in Domestic and Global Markets 56 Summary 59 Key Terms 59 CFA Institute 61 Multiple Choice 61 Review Questions 64 Video Activity 64 3 Economic Foundations: Money and Rates 67 Why It Matters 67 3.1Microeconomics 68 3.2Macroeconomics 76 3.3Business Cycles and Economic Activity 82 3.4Interest Rates 86 3.5Foreign Exchange Rates 89 3.6Sources and Characteristics of Economic Data 91 Summary 95 Key Terms 95 CFA Institute 96 Multiple Choice 96 Review Questions 98 Problems 98 Video Activity 98 4 Accrual Accounting Process 101 Why It Matters 101 4.1Cash versus Accrual Accounting 102 4.2Economic Basis for Accrual Accounting 104 4.3How Does a Company Recognize a Sale and an Expense? 107 4.4When Should a Company Capitalize or Expense an Item? 111 4.5What Is “Profit” versus “Loss” for the Company? 121 Summary 124 Key Terms 124 Multiple Choice 125 Review Questions 126 Problems 126 Video Activity 127 5 Financial Statements 129 Why It Matters 129 5.1The Income Statement 130 5.2The Balance Sheet 134 5.3The Relationship between the Balance Sheet and the Income Statement 138 5.4The Statement of Owner’s Equity 141 5.5The Statement of Cash Flows 143 5.6Operating Cash Flow and Free Cash Flow to the Firm (FCFF) 148 5.7Common-Size Statements 149 5.8Reporting Financial Activity 156 Summary 158 Key Terms 159 CFA Institute 159 Multiple Choice 160 Review Questions 161 Problems 161 Video Activity 162 6 Measures of Financial Health 165 Why It Matters 165 6.1Ratios: Condensing Information into Smaller Pieces 166 6.2Operating Efficiency Ratios 167 6.3Liquidity Ratios 172 6.4Solvency Ratios 174 6.5Market Value Ratios 176 6.6Profitability Ratios and the DuPont Method 182 Summary 186 Key Terms 186 CFA Institute 187 Multiple Choice 187 Review Questions 188 Problems 189 Video Activity 189 7 Time Value of Money I: Single Payment Value 191 Why It Matters 191 7.1Now versus Later Concepts 192 7.2Time Value of Money (TVM) Basics 193 7.3Methods for Solving Time Value of Money Problems 196 7.4Applications of TVM in Finance 214 Summary 222 Key Terms 222 CFA Institute 223 Multiple Choice 223 Review Questions 224 Problems 224 Video Activity 225 8 Time Value of Money II: Equal Multiple Payments 227 Why It Matters 227 8.1Perpetuities 228 8.2Annuities 231 8.3Loan Amortization 239 8.4Stated versus Effective Rates 243 8.5Equal Payments with a Financial Calculator and Excel 246 Summary 257 Key Terms 257 CFA Institute 258 Multiple Choice 258 Problems 260 Video Activity 261 9 Time Value of Money III: Unequal Multiple Payment Values 263 Why It Matters 263 9.1Timing of Cash Flows 264 9.2Unequal Payments Using a Financial Calculator or Microsoft Excel 271 Summary 278 Key Terms 278 CFA Institute 278 Multiple Choice 278 Review Questions 279 Problems 280 Video Activity 281 10 Bonds and Bond Valuation 283 Why It Matters 283 10.1Characteristics of Bonds 284 10.2Bond Valuation 288 10.3Using the Yield Curve 296 10.4Risks of Interest Rates and Default 301 10.5Using Spreadsheets to Solve Bond Problems 306 Summary 313 Key Terms 313 CFA Institute 315 Multiple Choice 315 Review Questions 317 Problems 317 Video Activity 318 11 Stocks and Stock Valuation 319 Why It Matters 319 11.1Multiple Approaches to Stock Valuation 320 11.2Dividend Discount Models (DDMs) 325 11.3Discounted Cash Flow (DCF) Model 341 11.4Preferred Stock 343 11.5Efficient Markets 345 Summary 347 Key Terms 347 CFA Institute 349 Multiple Choice 349 Review Questions 350 Problems 350 Video Activity 351 12 Historical Performance of US Markets 353 Why It Matters 353 12.1Overview of US Financial Markets 354 12.2Historical Picture of Inflation 362 12.3Historical Picture of Returns to Bonds 366 12.4Historical Picture of Returns to Stocks 370 Summary 376 Key Terms 376 Multiple Choice 377 Review Questions 378 Video Activity 379 13 Statistical Analysis in Finance 381 Why It Matters 381 13.1Measures of Center 382 13.2Measures of Spread 385 13.3Measures of Position 390 13.4Statistical Distributions 392 13.5Probability Distributions 396 13.6Data Visualization and Graphical Displays 400 13.7The R Statistical Analysis Tool 406 Summary 411 Key Terms 412 CFA Institute 413 Multiple Choice 413 Review Questions 414 Problems 415 Video Activity 415 14 Regression Analysis in Finance 417 Why It Matters 417 14.1Correlation Analysis 418 14.2Linear Regression Analysis 424 14.3Best-Fit Linear Model 427 14.4Regression Applications in Finance 431 14.5Predictions and Prediction Intervals 434 14.6Use of R Statistical Analysis Tool for Regression Analysis 438 Summary 442 Key Terms 442 Multiple Choice 443 Review Questions 444 Problems 445 Video Activity 447 15 How to Think about Investing 449 Why It Matters 449 15.1Risk and Return to an Individual Asset 450 15.2Risk and Return to Multiple Assets 458 15.3The Capital Asset Pricing Model (CAPM) 461 15.4Applications in Performance Measurement 465 15.5Using Excel to Make Investment Decisions 467 Summary 472 Key Terms 472 CFA Institute 473 Multiple Choice 473 Review Questions 474 Problems 475 Video Activity 476 16 How Companies Think about Investing 479 Why It Matters 479 16.1Payback Period Method 480 16.2Net Present Value (NPV) Method 482 16.3Internal Rate of Return (IRR) Method 486 16.4Alternative Methods 488 16.5Choosing between Projects 490 16.6Using Excel to Make Company Investment Decisions 496 Summary 501 Key Terms 501 CFA Institute 502 Multiple Choice 502 Review Questions 503 Problems 503 Video Activity 504 17 How Firms Raise Capital 507 Why It Matters 507 17.1The Concept of Capital Structure 508 17.2The Costs of Debt and Equity Capital 509 17.3Calculating the Weighted Average Cost of Capital 512 17.4Capital Structure Choices 516 17.5Optimal Capital Structure 520 17.6Alternative Sources of Funds 523 Summary 529 Key Terms 529 CFA Institute 530 Multiple Choice 530 Review Questions 532 Problems 532 Video Activity 533 18 Financial Forecasting 535 Why It Matters 535 18.1The Importance of Forecasting 536 18.2Forecasting Sales 541 18.3Pro Forma Financials 544 18.4Generating the Complete Forecast 546 18.5Forecasting Cash Flow and Assessing the Value of Growth 550 18.6Using Excel to Create the Long-Term Forecast 554 Summary 559 Key Terms 559 Multiple Choice 560 Review Questions 561 Problems 562 Video Activity 563 19 The Importance of Trade Credit and Working Capital in Planning 565 Why It Matters 565 19.1What Is Working Capital? 566 19.2What Is Trade Credit? 575 19.3Cash Management 577 19.4Receivables Management 579 19.5Inventory Management 583 19.6Using Excel to Create the Short-Term Plan 584 Summary 590 Key Terms 590 Multiple Choice 592 Review Questions 594 Video Activity 597 20 Risk Management and the Financial Manager 599 Why It Matters 599 20.1The Importance of Risk Management 600 20.2Commodity Price Risk 602 20.3Exchange Rates and Risk 604 20.4Interest Rate Risk 614 Summary 618 Key Terms 618 CFA Institute 619 Multiple Choice 619 Review Questions 621 Problems 621 Video Activity 622 Index 623

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